Fractional/minority discounts in private companies are appropriately applied when you transfer fractional interests that represent less than 50% of the equity in the entity or real property you own. The process begins with a proper determination of the interest’s fair market value, including the appraisal of the underlying company, partnership, LLC, or real property, and includes evaluation of the less than 50% interest’s lack of control and marketability. When an interest lacks the power to affect change to an entity or asset, that interest’s pro rata value is less than a majority interest’s that does enjoy such control. The interest’s value is adjusted or “discounted” accordingly. In a similar manner, an investor whose interest is not readily marketable (because the interest is not listed on any stock exchange, for instance) suffers from holding an illiquid security that may not be immediately (or ever) liquidated. That interest is adjusted or “discounted” for its lack of marketability. You begin the process of taking advantage of the discounts by speaking to an attorney near you that specializes in estate planning.
You can defer the capital gains tax on the appreciation in the company’s value and its securities from the day you founded the company and first received the securities to the day of its sale. If structured properly, you may defer paying the tax indefinitely. Second, there is a unique tax advantage when the ESOP borrows to finance the purchase of your shares, such that the repayment of the principal of the loan is tax deductible for your company. You will need an ERISA attorney or legal counsel that specializes in structuring and executing leveraged sales of securities to an ESOP.
It is your attorney that determines whether or not you require a fairness opinion. It is a financial advisor that creates the analyses and renders the opinion of fairness to a party with a financial interest in the transaction. A fairness opinion is a financial opinion that states the transaction is fair from a financial point of view to the party requesting the opinion. It is not merely a valuation of the company. The analyses begin there, then continue to consider and analyze the value of the specific consideration paid (most transactions include forms of payment other than cash); the value of the securities received; whether or not the exchange for what was surrendered was equal to the consideration received (that is, valuing the assets that are given up and the assets/securities that are received and whether they are equivalent or there is a deficiency); the process of the transaction; and whether any other party received a better deal or more favorable treatment than you did. This financial opinion includes concepts of absolute and relative fairness.
The calculation for properly allocating the fair value of a company’s equity to the equity securities is performed though the use of option models, or a technique known as PWERM, which directly calculates the value of the common stock under specific scenarios that simulate potential liquidity events for the investors. Only for very early stage companies that lack measurable development or a reasonably foreseeable exit strategy, do we simply allocate today’s equity value in the Company to all series and classes of equity securities as though the Company were to affect a liquidity event now.
Valuation firms, firms with valuation practices, and individuals that are experienced in financial analyses and accepted valuation techniques such as the company’s CFO, controller, and its institutional investors. While anyone can claim such expertise, due diligence on the experiences and track record of a provider of this service is strongly recommended to avoid potentially undesirable, time consuming, and costly outcomes that must be rehabilitated or replaced.
Pre-revenue companies are valued every day. Often these are companies without a commercialized product or companies that do not have the resources to bring their product or service to market. There may be a reasonable expectation that the Company’s pre-revenue circumstance will change in the near-term, or the timing of the change can be anticipated assuming outcomes stemming from a series of expected events. The value of an operating company resides in the future of its business, revenues, and cash flows. Pre-revenue companies are no different, but they are burdened with a unique characteristic of uncertainty resulting from no demonstrated historical performance, business operations results, or product sales. Once the pre-revenue companies start generating first revenue, their modest value can begin to appreciate very rapidly as they demonstrate traction in the marketplace for their products or services.
Not in every circumstance. Superiority is a function of the quality of supporting data and its application for a specific company at a particular stage of development or level of maturity. Value today is often described as the present value of all future economic benefits to be derived from an asset or company, adjusted for the uncertainty of achieving or receiving those economic benefits plus the time it will take for the benefits to be available to the equity investor. Since the factors that drive value and so much of the perceived uncertainty of the future can be expressed through the discounted cash flow model, most valuation practitioners will develop one whenever possible and use the model both as an indication of value and as a reasonability test when employing other going concern valuation methodologies. Other widely used valuation methodologies include the recent pricing and sale of subject company securities to third party investors and market techniques that compare a private company to similar publicly traded ones or to companies that have been acquired in a corporate finance transaction.
The value of intangible assets is usually developed through a discounted cash flow analysis or a replacement cost analysis. The methodology will vary with the type and circumstance of the particular asset. The amount or percentage of the purchase price allocated to the major intangible asset or intellectual property is determined by the future cash flows attributable to the major asset versus all of the other tangible and intangible assets of the business and its total cash flow. The difference between the purchase price of the company and the value of all of its identifiable assets is commonly allocated to “goodwill.” The residual amount allocated to goodwill varies for each company and transaction.
Brand equity measures the value of the reputation of the company or its product. It is the aggregation of all of the positive characteristics and associations known about the company or a product. Brand equity has value as long as it is one of the drivers of future business of the company or product. Your company did not have any brand equity when it was founded, save for the reputation of the founders. Brand equity takes time, investment, and much effort to create and grow. A trademark is a registration that is filed as a form of insurance in an attempt to protect your asset from poachers. Trademark protection is a defensive corporate tactic. You require an attorney to legally register a claim or to protect a proprietary asset. You create brand equity as your company or product achieves a reputation or image. A trademark is a symbol or words chosen to represent that reputation or image.
The NBA sports franchise known as the Los Angeles Clippers is expected to increase in value over time. Just as the price paid for other professional sports franchises has continued to appreciate over the years, so too are the new investors in the LA Clippers expecting to make a profit when the franchise is sold at some unspecified time in the future. Some sports franchises generate a profit for their owners during the period those investors hold the franchise, while others do not. Most investors do not require profitability during the holding period, but anticipate the franchise will sell for a higher price later. In the interim, they receive intangible but valuable “psychic returns” (similar to the benefit of owning a “trophy” real estate property) from the experience of participating in the membership of a very small, rarefied fraternity. This non-financial return on investment may be accompanied by collateral business opportunities or non-economic lifestyle benefits. Why do the current investors expect this sports franchise to be purchased at a high price in the future? Because sports franchises typically appreciate commensurate with the growth in the following: the number and enthusiasm of team fans; advertising revenues; ticket sales and prices; merchandise sales; concession prices; and expectations for continued growth in the future. The LA Clippers could be worth two billion dollars today provided that the demand for ownership of professional sports franchises remains robust and the demand from sports fans continues to drive franchise revenues and profits ever higher.